Big Ideas to Super-Size New Zealand's Economy

Outlines 10 policy changes which would help to accelerate our rate of economic growth at a symposium in Auckland hosted by the Centre for Independent Studies

Ladies and Gentlemen,

In a 12 minute speech, there is no time to dwell on the obvious:

that a gap has emerged between living standards in New Zealand and those in countries to which New Zealanders can readily move;

that this gap has become markedly larger over the last seven or eight years, particularly against countries like Australia, in large part because our trend growth in labour productivity has roughly halved as compared with the trend growth of the nineties;

that as a result, we are seeing an increasing number of New Zealanders leave the country permanently;

that we are increasingly unable to afford the good things of life that richer countries take for granted, such as a proper course of Herceptin for treating breast cancer;

that we are increasingly dependent on migrants to fill the gaps left by departing New Zealanders, so that, for example, we now have the highest percentage of foreign-trained doctors in the developed world with a New Zealand doctor leaving the country every week; and

that even the Government, when it is being completely honest, acknowledges that there is not the slightest chance of reaching the top half of the OECD by 2010, as was their original objective, or even of achieving the 4% trend growth which Michael Cullen said was his immediate aim in his 2002 Budget.

I think most people in this room also accept that simply cutting income tax rates to leave a few more dollars in the pocket of the average wage earner, perhaps by making marginal changes in income tax thresholds, will make no fundamental difference to this dismal picture; while pushing companies to pay Australian wages despite our much lower productivity per person in New Zealand is just plain dopey, unless the advocates of this course of action want to discourage employment by those companies.

Having spent four and a half years in Parliament, I suspect that the leadership of both our major political parties understands all this rather well. The problem is not their lack of understanding but the problem of explaining what needs to be done to an electorate with a rather short time horizon and a very poor understanding of what needs to be done.

I’m going to group my proposals under two main headings – macro and micro, though I admit the distinction is a bit artificial. All my proposals would, I believe, have a materially beneficial effect on improving our living standards.

I will not be touching on issues relating to climate change, and the measures which might be taken to reduce carbon emissions. This is partly because I suspect that David Skilling will touch on those issues in his speech and partly because I remain somewhat sceptical about the impact of human activity on the climate, and suspect that within five years many others will have come to share my scepticism. But let me just say in passing that there isn’t the slightest doubt that achieving big reductions in greenhouse gas emissions of the kind which both major political parties have committed to will almost inevitably have profoundly negative implications for our standard of living.

One other comment by way of introduction. I make no apology for the fact that none of the proposals I put forward today are brand new, in the sense that nobody has advocated them previously. Unfortunately, achieving higher living standards involves doing a whole lot of things which are now widely understood by policy-makers, even if not by the general public.

Macro proposals

1) Improve the education system. By this, I don’t mean throwing vast amounts of additional money at university students. Yes, tertiary education is important for our future, but I strongly suspect that the quality of our pre-school, primary, and secondary education is of even more fundamental importance to the productivity of our work-force. Far too many New Zealanders are barely literate and barely numerate, and they will never be highly productive in an economy increasingly dependent on employees being both literate and numerate. Does this mean more government spending on education? Probably not: government spending on education already makes up a higher percentage of our GDP than is the case in most other developed countries. What is required is better trained teachers, and a remuneration system in the education system which differentiates between good teachers and those who should be looking for another career. That almost certainly implies giving parents more choice about where their children are schooled.

2) Change the welfare system so that it encourages people back into the workforce. On the face of it, participation in the paid workforce is already fairly high by developed country standards, but it’s still true that, despite employers up and down the land being desperate to hire staff, the number of working age adults who still depend for their primary source of income on the state is well in excess of 250,000. Many of these dependents are allegedly sick or injured, although why the number of those sick and injured should have increased by 50% since 2000 is frankly beyond me – the increase strongly suggests that there has been significant migration from the mildly work-tested Unemployment Benefit to the un-work-tested Sickness and Invalids Benefit. Many others are on the Domestic Purposes Benefit, where the eligibility criteria allow uneducated teenagers to make a lifestyle choice in favour of single parenthood, to their own huge detriment and to the detriment of their children. The current welfare system not only involves very substantial fiscal cost but discourages too many people from entering the workforce, with social as well as economic costs.

3) Hold government spending at present levels, per capita, in real terms. This hardly sounds like an ambitious target. It implies a steady increase in government spending in nominal terms, both because of inflation and because of population growth. It simply implies holding current levels of real spending on a per capita basis. If the population increases, or if prices increase, then government spending goes up to compensate. But achieving such a goal would involve stopping the substantial growth in real government spending per capita which the present Government plans. The 2008 Budget Policy Statement projects an increase in inflation-adjusted government spending per capita between the 2004 financial year and the 2012 financial year of more than 28%, or some $9,000 per household. That is a truly massive increase in government spending per capita, in real terms, and seems impossible to justify other than in crudely political terms. If, instead, real government spending could be held at current levels, on a per capita basis, the scope to provide tax reductions which would give the private sector more space to grow would be very considerable indeed.

4) Constrain the growth in government regulation. The Australian Productivity Commission estimates that complying with regulations in that country costs 4% of GDP, or about A$40 billion in money terms. And that is the cost of complying with regulations. Unquantified, and probably unquantifiable, is the almost certainly much greater cost imposed by regulations which simply stop investment occurring altogether. In recent years, there has been an explosion in the quantity of legislation and regulation which people and companies have to comply with, most of it enacted with the utmost of good intentions. When I was Governor of the Reserve Bank, I made the decision to impose on the banks a disclosure regime designed to ensure that they behave prudently, to minimise the risk that they might get into difficulty. My intention was to use public disclosure to put pressure on bank managers and directors to operate in sensible ways. I don’t resile from that decision. But having been a director of a bank myself now for much of the last year, I have realised that the system which I initiated has created very large compliance costs. It’s overkill. For large banks, the quarterly disclosure statement is around 100 pages in length – no doubt ideal material for insomniacs but a huge barrier to normal members of the public, or even dedicated financial journalists. Most of the information needed by the public is available in the three or four page Key Information Summary which banks are also obliged to publish. There would be considerable merit in some form of legislation to create a hurdle which all new legislation and regulation would have to clear before coming into effect, with the objective of minimizing the cost of regulation.

5) Give the Reserve Bank an additional instrument to moderate inflationary pressures. Everybody in the export sector, and indeed everybody competing with imports, knows the acute problem caused by big swings in the exchange rate, caused in part by financial markets’ perceptions of what the Reserve Bank is likely to do with the Official Cash Rate. I’m not talking about the day to day, or week to week, volatility of the exchange rate. There are plenty of market mechanisms available to protect against those short-term fluctuations. The real problem is caused by the five to seven year swings. No exporter, wondering whether to make an investment, can cover the exchange risk for, say, the next seven years – there is virtually no market for seven-year forward contracts, and even if there were, no exporter would know with confidence the value of his exports seven years into the future, or the currency in which they would be denominated. So when the NZ dollar increases in value from less than 39 US cents in late 2000 to close to 80 US cents today many exporters struggle to stay afloat and many more are forced to scale back their businesses. Many will swear to focus more on the domestic market in future. And yet we need to increase our exports, as David Skilling may well point out. I believe the Reserve Bank best serves New Zealanders, both socially and economically, by keeping prices stable, but I have come to the conclusion that using only the Official Cash Rate to do that puts far too much pressure on exporters and those competing with imports because of the effect which the OCR has on the exchange rate. As I have indicated elsewhere, I would favour giving the Reserve Bank a constrained authority to vary the excise tax on fuel – increasing it when there’s a need to restrain overall spending because of strong inflationary pressures and reducing it when there’s a need to stimulate overall spending when inflationary pressures are very weak. This should lead to smaller swings in the exchange rate and less variability in interest rates, to the benefit of homeowners, exporters, and those competing with imports as well.

Micro proposals

6) Flatten the income tax scale and limit the maximum tax payable to $1 million. Most of the current discussion about tax cuts seems to be about letting people keep more of their own money, and in itself that’s entirely desirable. But the relevance of tax to long-term living standards mainly relates to the marginal tax that people pay on the next dollar of earned income. Having a beneficiary face an effective marginal tax rate of 80 cents in the dollar is no way to encourage him, or her, to get off a benefit and into the workforce. Having a tradesman face an effective marginal tax rate of over 50%, by the time income tax and Working for Families abatement are taken into account, is no way to encourage him to work harder, or expand his business. It would significantly change those incentives if the effective marginal tax rate were much lower. It would also greatly simplify compliance with the tax system if there were fewer tax rates. There is a real danger in this election year that very large amounts of tax revenue will be foregone as part of a vote-buying tax auction while leaving the basic structure of the tax system, and the high effective marginal tax rates, substantially untouched. That would be an enormous wasted opportunity, though I understand only too well the political obstacles to a more rational tax system. I can already hear the taunts of Labour Party politicians if John Key proposed flattening the tax scale, even though that might well be one of the best contributions he could make to help low-paid New Zealanders.

There would also be merit in adopting another of the recommendations of the Government’s own Tax Review Committee in 2001, namely limiting the amount of tax paid by any one individual in one financial year. The Review Committee recommended a limit of $1 million. Adopting such a limit would also be politically difficult because so much of our current debate on tax is based on crude envy, but it would certainly make sense economically. Very few New Zealanders, if any, pay income tax of more than $1 million annually now; $1 million is more than sufficient to cover the costs imposed by any one taxpayer on the rest of society; and adopting such an approach would almost certainly be revenue positive by attracting back to New Zealand a number of expatriate Kiwis who have gone abroad to more “friendly” tax jurisdictions, as well as attracting wealthy Americans, Europeans and Asians. Quite apart from the revenue gain from such a measure, the increase in entrepreneurial dynamism from such an influx of successful business people would be a substantial gain.

7) Fix the Resource Management Act and HSNO Act. I rather strongly suspect that the RMA does more to inhibit New Zealand’s economic growth than any other single piece of legislation. It makes getting consent to undertake almost any kind of investment an incredibly expensive, risky, and time-consuming process. I think it was Transit New Zealand that pointed out some years ago that getting approval to build a major road in New Zealand can take seven years, as compared with seven days in Singapore. Nobody thinks that we can cut our approval times from seven years to seven days any time soon, but seven years is ridiculous. And it was the Forest Industries Council which pointed out two or three years ago that at that time there were 21 major wood-processing plants under construction in Australia but none at all in New Zealand, and the Council laid most of the blame for that situation on the RMA. Nobody in this room wants to destroy our natural environment, but without a major re-write of the RMA we have very little chance of again achieving Australian living standards.

The HSNO Act also is a major impediment to investment, especially in our vital agricultural and horticultural industries. It has had a major impact on slowing the introduction of new plant varieties.

8) Remedy our serious deficit in roading infrastructure, and price road usage correctly. For all the talk about public transport and the benefits of improving our rail system, the evidence is overwhelming that rail systems rarely pay their way while roading infrastructure has a substantial payoff in terms of economic growth. New Zealand almost certainly has a serious deficit in roading infrastructure, not only in major metropolitan areas like Auckland but also in many North Island rural areas as well. I say “almost certainly” because one of the things we can’t be sure of is the extent of that deficit in a situation where we continue to allow people to treat the roads as free at point of use. Of course, motorists contribute to the cost of roads through petrol excise tax, but that tax is the same no matter when or where roads are used; and motorists also contribute to the extent that they are ratepayers, where the amount paid bears absolutely no relationship to when or where roads are used, or even whether roads are used at all. When I argue for pricing road usage by some form of electronic tolling – with tolls varying depending on when the roads are used – most people say such a move would be politically impossible. I don’t agree: I strongly suspect that people would accept electronic road pricing if told that petrol prices would drop by 30 or 40 cents per litre, with a 25% drop in their rates. Of course, some people would end up paying more under such a system just as some people would end up paying less, but everybody would benefit by a marked reduction in traffic congestion.

9) Allow easier dismissal of unsatisfactory employees, especially in the first three months. Yes, I know, this is a hardy annual on the agenda of all business lobby groups, but that surely doesn’t invalidate it. On the contrary, the fact that every business lobby group, and every business person I’ve ever met, and the Government’s own Small Business Advisory Group make this point shows how widely felt this concern is. New Zealand is now the only developed country which effectively prevents employers taking on a new staff member on a probationary basis, and when current intense pressures in the labour market abate, there can be little doubt that the people most disadvantaged by the absence of a probationary period are the poorly educated, and members of minority ethnic groups, and recent immigrants, and those with a criminal conviction in their past, the very people whom our society should be trying to help. But just as making it difficult and expensive to lay off unsatisfactory staff, or staff who are no longer needed because of a change in the business environment, disadvantages the poorest in our community, it also increases risk for those contemplating investment, and reduces our growth potential.

10) Free up more land for housing. It is increasingly being recognised that the main reason that houses in New Zealand have become severely unaffordable – with the median house price in our major cities some six times the median household income – is that local and regional governments have imposed tight restrictions on the availability of residential land through their zoning rules. Of course, this has had serious social consequences, with more and more young New Zealanders finding it impossible to buy a first home. But it has almost certainly had profound economic consequences as well, driving a huge increase in consumer spending from the perceived increase in the “wealth” of home owners, leading in turn to a large balance of payments deficit, a heavy dependence on the savings of foreigners, an undesirably high exchange rate (the consequence of the Reserve Bank’s having to lean against the inflationary pressures generated directly and indirectly by the rise in house prices), and a diversion of a high proportion of available savings into building ourselves more and more lavish houses – much of it on money borrowed from foreigners. Politically, this problem can’t be solved overnight, but solve it we must.

So there you have it: Don Brash’s 10-point plan to increase our living standards! None of it is politically impossible, but implementing it would take courage because the pay-off would not be instantaneous. But there would be a pay-off. Young New Zealanders would still want to go overseas to see the world, as they have always done. The difference this plan would make is that a high proportion of them would want to come home.